Yesterday March 23, I released a note to clients and posted it here on Seeking Alpha and on titled: "Inversion in USD and Sterling Swap Spreads - Negative Swap Spread - and The Alarm It May be Raising".
A copy of the client note forwarded to risConometrics’ clients is here.
In the note, I mentioned the inversion in the swap rates and what I hope it is not implying. Specifically, the red flags raised in the note were:
- Is the swap spread turning negative on entirely technical factors (such as hedging induced by negative gamma exposures) or is it harbinger of a more fundamental change in risk perceptions – namely the increase in betas of sovereigns as risk entities relative to corporates?
- How much of the inversion is on account of increase in govy yields per se? If govies blow out, mortgage rates will inevitably follow. Double whammy for deficits and housing?
"A sudden drop-off in investor demand for U.S. Treasury notes is raising questions about whether interest rates will finally begin a march higher—a climb that would jack up the government's borrowing costs and spell trouble for the fragile housing market.....
This week, some investors turned up their noses at three big U.S. Treasury offerings.....The poor demand, especially from foreign investors, sent the bonds' prices sharply lower and yields higher. It lifted the yield on the 10-year note to 3.9%—its highest since last June, and approaching the psychologically important 4% mark. That mark has been pierced only briefly since the financial crisis in 2008.
Investors' response marked a big shift from auctions in recent months in which major foreign buyers, such as central banks, had snapped up Treasurys. It could spell trouble for the U.S. housing market; the rates on many mortgages are linked to the yield on the 10-year note.
The move up in its yield coincides with the impending end of the Federal Reserve's program to support the mortgage market. The Fed has bought $1.25 trillion of mortgage-backed securities, bolstering their prices and thus holding down their yields.
In the past two days, mortgage rates have also ticked up. The average 30-year mortgage rate rose to 5.13% on Thursday from 5.06% on Monday, according to HSH Associates in Pompton Plains, New Jersey............There are some temporary factors behind the lackluster demand for this week's Treasury offerings, such as a reluctance by Japanese investors to make new investments ahead of their fiscal year-end March 31........Adding to the focus on the Treasury market's woes this week has been an unusual development in an important, but usually ignored, market: interest-rate swaps. These common derivatives entail contracts that typically involve trading one stream of interest income for another. And in the past week, investors are being paid more to own U.S. Treasurys than U.S. corporate bonds.
This week, some investors turned up their noses at three big U.S. Treasury offerings, a big shift from auctions in recent months in which major foreign buyers, such as central banks, had snapped up Treasurys. It could spell trouble for the U.S. housing market; the rates on many mortgages are linked to the yield on the 10-year note.....
Let us hope these signs are a minor blip and not the double whammy in the making!